How would you measure the health of the overall economy? Take a second, think about it. All right, read on! It turns out that the Pew Charitable Trust has wondered the same thing. When their researchers surveyed people as to what influenced their views of the economy, they found that wages and the availability of jobs were among the most mentioned. Shocking? Hardly. After all, the vast majority of Americans get the vast majority of their income from the labor market. But, if you follow the recent correlation between labor market reports and the stock market, you’d be forgiven for thinking that a solid labor market is actually an economy killer. What’s going on?
The answer has to do with another thing that people mention when they talk about the economy — prices. As I’ve discussed before, the Federal Reserve’s fight against inflation involves a fight against labor markets. And, when it looks like The Fed is losing that fight — i.e., when the job market looks too good — the stock market gets spooked. Let’s start by talking about the current state of labor markets, then turn to some recent correlations between labor markets and stocks. And I’ll close with a bit of a look ahead. Get pumped for some info!
How’s that Labor Market Looking?
The September 2022 Employment Situation Summary, released October 7th, was pretty darn good. For example, the unemployment rate fell to 3.5 percent. That’s exactly where the rate sat in February 2020, prior to the start of the COVID-19 pandemic.
And, other measures of labor market performance look pretty strong too. The number of people filing new unemployment claims — a measure indicating new layoffs — also remains low relative to pre-pandemic averages. So people aren’t losing their jobs. Quite the opposite in fact — employers want workers and can’t find them.
Don’t believe me? Just look at the Bureau of Labor Statistics Job Opening and Labor Turnover Survey, or JOLTS (what a cool abbreviation for a dataset!). The data show that the job opening rate is still at a multi-decade high. So is the quit rate. So, employers are still looking for workers, and workers still feel confident quitting their jobs to find something else.
Figure 1. Job Opening and Quit Rates, 2001 – 2022
The take away from Figure 1 is that the labor market is still hot. Which is odd. Because the stock market sure as heck isn’t.
How’s that Stock Market Looking?
As good as the labor market looks, the stock market looks about that bad. On January 1st, 2022, the S & P 500 — an index often used as a benchmark for the stock market — sat at about 4,800 points. On Friday October 14th, it closed at about 3,600 points. If you are doing the math, that’s about a 25 percent drop. Yet, that drop has occurred at the same time that the unemployment rate — an index often used as a benchmark for the labor market — improved from 3.9 percent to 3.5 percent. So, the stock market has moved in the opposite direction from the labor market.
The reason for this inverted relationship has to do with the biggest headwind for the economy at this time — inflation. The Federal Reserve is in full inflation fighting mode, and the Fed’s primary tool in this respect is to keep interest rates high. High interest rates make it hard for consumers and companies to borrow money. If consumers and companies can’t borrow money, that should lower demand for a variety of products, ultimately bringing prices back under control. A key signal of successful economy “cooling” would be faltering labor markets.
So, when labor markets look good, it sends a signal to investors that this Fed policy might need to continue. Which is how you end up with headlines like: “Stocks tumble … as [f]resh data showing continued strength in the labor market solidified investors’ expectations that the Federal Reserve will need to keep acting aggressively to cool the economy.” And, it’s how you get a stock market drop of 2.9 percent — the 12th worse day of stock returns this year — on October 7th, a day when the jobs report was pretty darn solid.
The question on everyone’s mind is what happens going forward. Will the Fed’s goal of fighting inflation succeed? And, will that success come at the expense of the labor market?
In the past, that relationship — lowering inflation requires higher unemployment — was the norm. In any entry-level Macroeconomics course, students learn about the “Phillips Curve.” The Phillips curve plots the relationship between unemployment on the x-axis and inflation on the y-axis. Historically, this curve has been downward sloping; as unemployment increases inflation decreases. Hence, a good labor market report causes worry that inflation continues, and stocks fall on the fear that The Fed keeps raising interest rates.
But, it’s also worth noting that this relationship is more of a historical legacy than a current fact — the original curve was first written about in the 1950s. Through the 1960s, that downward slope held. But, more recently the curve has been flatter, giving some hope that maybe lowering inflation doesn’t absolutely need to spike unemployment.
Adding to that hope is the job opening rate from the figure above. If you squint, you can see the opening rate falling recently. That gives me hope that the Fed can cool the labor market by killing off those extra job openings, without killing off the jobs that people already have. We will see what the future holds. But for now, in the fight of labor market versus stock market, the labor market seems to be winning.